Since re-listing in 2014, Spotless Group Holdings Ltd (ASX: SPO) has outperformed the S&P/ASX 200 (ASX:XJO) (Index:^AXJO) by more than 25%. After reaching its all time high of $2.52 in April however, the share price has fallen by more than 12%.
Could this be a buying opportunity or a signal to avoid it? Only time will tell, but here are a few points about Spotless that could help investors make up their own minds:
Background
Spotless is a market leader in Australia and New Zealand in providing catering, maintenance, cleaning, laundry and linen services. It has a diverse group of long-term customers including government bodies and large multinationals.
Spotless was publicly listed before it was purchased by private equity in 2012 before re-listing in 2014. The reorganisation of the company since 2012 has improved profitability and operational efficiency but there still remains areas of opportunity for the company.
Contracts
The company generates more than 80% of its revenues through contracts. Pleasingly for Spotless, they were either awarded new contracts or managed to renew existing contracts over the past 12 months. Spotless also has a pipeline of possible contracts in place to provide further growth and has proven itself to be successful when tendering for large contracts.
The average contract length is five to six years and that makes it easy for management to forecast expected revenues. In addition to this, the vast majority of its contracts contain some form of embedded price growth mechanism which helps to protect Spotless' margins.
Acquisition
Spotless is continually looking for strategic acquisitions that will boost returns for their shareholders and provide the company with a competitive advantage. Spotless has specifically acquired new bolt-on businesses which can expand its traditional service offering and give its customers the biggest range of services possible.
Most recently, it announced the acquisition of Australia's leading provider of retail utility meter reading and installation services as well as the acquisition of Australia's leading air-conditioning and mechanical services provider.
Financial Results
The most recent half yearly result was well received by the market as evidenced by the steady increase in the share price. Revenue and profit growth met prospectus forecasts and increased by 4.5% and 23.6% respectively. Free cash flow increased strongly, while net debt remained fairly constant.
Management has recently re-affirmed full year guidance with net profit after tax forecast to increase by a further 23% over the half-year result.
Management changes
One issue facing Spotless is the search for a new chief executive. The shares were sold down heavily following the announcement that current chief executive Bruce Dixon would step down from the top job. Mr Dixon was instrumental in the recent success of the business and investors should be cautious when key personnel are replaced.
Valuation
Spotless is trading on a forward price-to-earnings ratio of around 17 at the current share price of $2.18. Based on management's forecasts of a 75% payout ratio, investors should expect a dividend yield of around 4.2%.
Foolish takeaway
Spotless is well positioned for further growth through acquisitions and increased tendering for new contracts. With that in mind, I feel the share price may be slightly overvalued at the current price as profit growth is expected to grow more slowly over the medium term. If I was an existing shareholder I would be happy to hold on to my shares, but I would wait for the share price to fall below $1.95 before becoming a new shareholder.
